If the contribution margin is not sufficient to cover fixed expenses: a. total profit equals total expenses. b. contribution margin is negative. c. a loss occurs. d. variable expenses equal contribution margin.
The Correct Answer and Explanation is:
The correct answer is c. a loss occurs.
Explanation:
The contribution margin is the difference between total sales revenue and total variable expenses. It shows how much money is available to cover fixed expenses and contribute to profit.
Here’s a breakdown of the key terms:
- Contribution Margin: This is calculated as Sales Revenue – Variable Expenses.
- Fixed Expenses: These are the costs that do not change regardless of the production or sales volume, such as rent, salaries, and insurance.
- Profit or Loss: If the contribution margin is greater than fixed expenses, a profit will occur. If the contribution margin is less than the fixed expenses, a loss will result.
Now, when the contribution margin is not sufficient to cover the fixed expenses, the business will face a situation where it cannot break even or generate a profit. In other words, the business will have a loss.
Let’s break down the other options:
- a. Total profit equals total expenses: This occurs when the contribution margin is exactly enough to cover fixed expenses, meaning the company breaks even, not incurs a loss.
- b. Contribution margin is negative: A negative contribution margin would imply that the variable expenses exceed the sales revenue, which is a different scenario that could also lead to a loss, but it’s not directly related to the fixed expenses.
- d. Variable expenses equal contribution margin: This would suggest that the company is just breaking even in terms of covering its variable costs, but it does not address the fixed expenses, which is why this scenario would also lead to a loss if fixed expenses are not covered.
Thus, if the contribution margin isn’t enough to cover fixed expenses, the company will incur a loss.
